THE HAGUE Italy, beset by yet another government crisis, cannot afford political instability at a time when it needs to make its economy more competitive, the chairman of euro zone finance ministers said on Thursday.

Italian Prime Minister Enrico Letta faced a showdown in his own center-left party on Thursday that could lead to his resignation and the appointment of Democratic Party leader Matteo Renzi as head of a new government within days.

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"I don't think Italy can afford that and I don't think any country can really afford that," Dijsselbloem said in his office in The Hague. A lot of work has to be done also in Italy in terms of competitiveness, productivity, labor markets etc."

The euro zone's third largest economy sold the highest planned amount of bonds and paid the lowest three-year yield on Thursday as investors awaited the outcome of a meeting of the leadership committee of Letta's Democratic Party (PD) starting at 11 a.m. ET.

The European Commission expects Italy's economy to return to growth this year with a 0.7 percent rise after two years of contraction. Public debt, seen peaking this year at 134 percent of the economic output, is more than double the EU's ceiling.

Italy's main business lobby accused Letta's government last month of failing to help the economy and demanded a cut in public spending and easing in taxation and labor rules.

RESULTS FIRST, LENIENCY LATER

To make Europe more competitive, Dijsselbloem said, EU institutions had to change their approach to granting more time to fix budgets deficit and debt overruns in return for promises to reform.

"If you want more time to deal with your budget, fine, but then you have to do more in terms of reform," he said.

"The Commission should be much tougher ... and the conditions should be you have to move forward reforms X, Y, Z within A, B or C months, within a limited amount of time you have to show results of reforms because otherwise I will hold you to your budget obligation," he added.

EU Economic and Monetary Affairs Commissioner Olli Rehn took a similar line at the Reuters summit on Monday, drawing lessons from the leniency shown to France, which was given two extra years to cut its deficit to 3 percent of GDP without explicit reform conditions.

Rehn said the EU executive may in future demand proof of reforms first before granting governments more time to reduce excessive budget deficits.

While economies of Greece and Portugal undergo fundamental reforms in return for financial assistance to keep them afloat, the bloc's economic heavyweights like France struggle to follow suit while getting more time to deliver on budgetary promises.

"Some countries have been given more time and implicitly they have promised or the Commission has hoped that there would be reforms. We should change that around. It should be explicit," Dijsselbloem said.

In one of the most far-reaching responses to the region's debt crisis, the European Commission assumed new powers last year to review member states' budget plans before they are adopted by national parliaments.

The aim is to raise a red flag before it is too late and prevent a repeat of the turmoil of the past four years, which began because countries such as Greece were living beyond their means.

"Even to my surprise the mechanism works," Dijsselbloem said. "The peer pressure, the possibility of the Commission stepping in and putting sanctions on a country, the mechanism is working.

"The next step for me would be to have a connection between budgets and reforms," he added.

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